Hon Hai Squeezes Taiwan's Notebook Makers

By

Ting-I Tsai

Updated Dec. 8, 2010 6:07 p.m. ET

TAIPEI—Taiwan's manufacturers, which assemble more than 90% of the world's notebook computers, are being forced to merge with their component suppliers as already-shrinking profit margins face an even greater threat: the entry of heavyweight Hon Hai Precision Industry Co.2317-0.22%

ENLARGE

A man tries the Acer Aspire One netbook at a computer mall in Taipei September 8, 2009. As the PC industry embarks on a fitful road to recovery, many are betting that Taiwan's Acer and HP will lead the rebound with surging netbook sales and a strong presence in booming Asia. To match analysis PC-RECOVERY/ REUTERS/Nicky Loh (TAIWAN BUSINESS SCI TECH)
Reuters

The major computer brand names, such as Hewlett-Packard Co.HPQ-0.33%, Dell Inc. and Acer Inc., are playing the island's notebook manufacturers against each other to keep costs down, even as labor and raw materials prices rise; that pressure also helps keep prices down for consumers.

The entry this year into the notebook market of Hon Hai, the world's largest contract maker of electronics products and already a key supplier of components to the notebook makers, only raises the competitive stakes further.

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The notebook manufacturers are turning to vertical integration with their component suppliers in an effort to slash overhead. These notebook makers' average gross margin has narrowed to 4% or lower this year from 7%-8% in 2003.

Hon Hai, known in the industry for cutting costs, had for years focused its PC business on making components and desktops, but this year moved into notebook manufacturing.

Besides iPads and iPhones for Apple Inc.,AAPL-0.87% Hon Hai also makes PCs, cellphones and videogame consoles for most of the biggest electronics brands, including H-P, Nokia Corp.NOK0.28% and Nintendo Co.

The company is a master of vertical integration: Hon Hai or its affiliates make many of the components used in the computers and gadgets sold to the big brand names, providing a competitive advantage.

ENLARGE

Terry Gou, founder and chairman of Hon Hai Group.
Bloomberg News

Hon Hai, also known by its trade name Foxconn, entered the desktop computer business decades ago by making cable connectors, and has since moved into motherboards, cases and flat-panel displays, among others—either directly or through affiliates. Components often carry relatively meaty margins, which means Hon Hai can offer extremely low prices on assembly and still earn money.

Its smaller rivals in notebook assembly, long subject to smaller economies of scale, are moving bring their suppliers under their own roofs in an effort to beat Hon Hai at its own integrated game.

Hon Hai doesn't disclose financial details of its component units, and none of the PC makers is willing to share details of their business ties with Hon Hai.

Representatives from Hon Hai, H-P, Dell and Acer declined to comment.

Calvin Huang, analyst at Daiwa Securities, suggested that a Hon Hai affiliate, Foxconn Technology Co., is "likely to keep losing notebook-related business, including light-metal and thermal modules," as its revenue hasn't grown as much as its rivals in the past few months.

But even if Hon Hai does lose orders to its smaller competitors in the notebook sector, it is so sprawling that it can convert most of its component production into lines for printers, game consoles and smartphones, said Robert Cheng, an analyst at Credit Suisse.

In response to that strength, the Taiwan notebook makers are closing ranks.

In early September, Compal said it would form an LCD joint venture with South Korea's LG Display Co

News of that deal came shortly after Pegatron said it would acquire a leading casing manufacturer, Ri-Teng Computer (Shanghai) in late August.

Wistron, which makes notebooks for Acer, announced in August a joint venture to produce panel modules in China with AU Optronics Corp., a flat-panel maker.

"A successful vertical integration will be very helpful to cost control," said Jonathan Chang, spokesman at Pegatron, "It is a good incentive to land orders…..and makes clients more reluctant to leave."

Pegatron, which has manufactured most of its own components for four years now, said these investments in suppliers not only cut costs but also increase efficiency, reducing time for delivery and development of new components.

The notebook PC makers have also branched out into a range of other products over the past decade, including smartphones, videogame consoles and television sets, to boost shrinking margins. But none of them have been as diversified as Hon Hai.

According to analysts, Hon Hai has landed orders to manufacture some 20 million units of notebooks for H-P. Within couple of years, Hon Hai is likely to push one or two PC assemblers out of the market, analysts said.

"I expect that over the next two years we would see up to two [original design manufacturers] exit the notebook business and turn to other product manufacturing or exit manufacturing all together," said Michael Palma, analyst at research firm IDC.

Notebook PC manufacturers have focused on merging the major parts, including casing and connectors in the past couple of years.

In 2008, Quanta invested $39.6 million in casing and metal component manufacturing, and invested an additional $27.9 million in the same categories in 2009. Compal, meanwhile, has invested some $91 million since 2007.

Compal spokesman Gary Lu said the company remains interested in merging more component manufacturers that make advanced key components, not those already standardized ones.

Quanta, Wistron and Pegatron all said they remained interested in merging more component makers once they are available in the market.

It remains to be seen if the strategy is paying off: Operating component factories requires a different kind of expertise from the manufacturers' traditional strengths, and high volume is needed to bring down cost.

Compal, for instance, in October 2009 sold its panel affiliate, TPO Displays Corp., after years of losses. Pegatron has been suffering from not landing enough orders after it officially split from netbook creator Asustek Computer Inc.ASUUY-6.93% earlier this year.

Some analysts also see the vertical integration as unnecessary.

"Producing your own components is like keeping a cow for drinking milk," said Mr. Cheng, the analyst at Credit Suisse. "These companies have made lots of cash for years. Rich people just think they ought to make everything on their own."

A Pegatron spokesman said the same debate occurs on whether car makers should manufacture their own components.

"We believe this is the only way allowing us to effectively respond to electronic gadgets' short life cycle," he said.

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